Executive SummaryShare

China continues to limit foreign investment in key economic sectors by requiring joint ventures with domestic Chinese firms, restricting ownership and shareholder rights of foreign investors, and outright prohibiting investment in some sectors. While China in 2017 made modest market access liberalizations in some sectors, China’s investment environment continues to be more restrictive than its major trading partners, including the United States.

China remains one of the top destinations for global foreign direct investment; however, many sectors of China’s economy remain closed to foreign investment. China historically has used the Catalogue for the Guidance of Foreign Investment in Industries, also known as the “Foreign Investment Catalogue” (FIC), to segment foreign investment into “encouraged”, “restricted”, or “prohibited” categories. In June 2017, China released an updated version of the catalogue that was rebranded as the nationwide “negative list.” China announced openings in a few new industries, including: edible seed oil processing; rice, flour, sugar, and corn processing; biofuels; credit ratings and valuation services; and motorcycle manufacturing. However, important and key industries remained restricted to foreign investment, including financial services, culture, media, telecommunications, vehicles, and transportation equipment.

China has a restrictive foreign investment approval system that shields inefficient and monopolistic Chinese enterprises in many industries – especially state-owned enterprises (SOEs) and other enterprises deemed “national champions” – from competition from private and foreign companies. In addition, foreign investors experience a lack of transparency and a lack of rule of law in China’s regulatory and legal systems, including discriminatory practices, selective enforcement of regulations, and a judiciary subject to interference by the Chinese government and the Chinese Communist Party (CCP). Moreover, China’s industrial policies, like Made in China 2025 (MIC 2025), rely on poor enforcement of intellectual property rights (IPR), forced technology transfers, and a systemic lack of rule of law to inherently discriminate against foreign companies and brands by favoring local products in key high-tech and advanced manufacturing industries.

During the Chinese Communist Party’s (CCP) 19th Party Congress held in October 2017, the CCP leadership underscored Xi Jinping’s primacy by adding “Xi Jinping Thought on Socialism with Chinese Characteristics for the New Era” to the Party Charter. In addition to significant personnel changes, the Party announced large-scale government and Party restructuring plans in early 2018 that further strengthened Xi’s leadership and expanded the role of the Party in all facets of Chinese life: cultural, social, military, and economic. An increasingly assertive CCP has raised concerns among the foreign business community about the ability of future foreign investors to make decisions based on commercial and profit considerations, rather than political dictates from the Party.

While market access reform has been slow, the Chinese government has pledged greater market access and national treatment for foreign investors through the following announcements:

State Council-issued circulars 5 (January 2017), 39 (August 2017), and 19 (June 2018) announced future foreign investment liberalization in several economic sectors like alternate energy vehicles, banking, securities and insurance, shipping vessels, call centers, and internet/media content businesses. In addition, the circulars said financial incentives would be provided to foreign investors in high-tech and high-value added services industries (or MIC 2025 fields, which will be detailed in a later section of the report), and foreign investors were promised national treatment in China’s legal system, currency flows, IP protections, and overall investment approval system. The most recent circular, number 19, includes provisions to adhere to World Trade Organization (WTO) commitments on joint ventures, explicitly prohibiting local officials from using administrative means to force technology concessions for foreign investment.

On June 28, the National Development and Reform Commission (NDRC) and Ministry of Commerce (MOFCOM) jointly announced the release of Special Administrative Measures for Foreign Investment Access (the “nationwide negative list”), which replaced the FIC. The new negative list was reformatted to remove “encouraged” economic sectors and divides restrictions/prohibitions by industry. Some of the liberalizations were previously announced, like financial services and insurance (November 2017) and automobile manufacturing and shipbuilding (April 2018).

On June 30, NDRC and MOFCOM jointly released the Special Administrative Measures for Foreign Investment Access in the Pilot Free Trade Zones (the Free Trade Zone (FTZ) negative list). The FTZ negative list matches the nationwide negative list with a few exceptions, including: foreign equity caps of 66 percent in the development of new variety crops of corn and wheat (the nationwide cap is 49 percent), removal of joint venture requires on oil and gas exploration, and removal of the prohibition on radioactive mineral smelting and processing (including nuclear fuel production).

While further market access liberalization and fair treatment of foreign investment is welcomed, these announcements lack implementation details and timelines. Even with greater market access, foreign companies will still be subject to inconsistent regulations, growing labor costs, licensing and registration problems, shortages of qualified employees, insufficient intellectual property (IP) protections, and other forms of Chinese protectionism that have contributed to China’s unpredictable and discriminatory business climate.

1. Openness To, and Restrictions Upon, Foreign InvestmentShare

Policies Towards Foreign Direct Investment

Foreign direct investment (FDI) has historically played an essential role in China’s economic development. China still restricts foreign investment in multiple sectors by requiring joint venture arrangements with Chinese companies, limiting foreign investment control by restricting shareholder rights, or, in some industries, prohibiting foreign investment outright. However, government officials continue to encourage foreign investment to further develop segments of China’s economy. Due to stagnant FDI growth over the past few years, along with a significant gap in technology and labor capacities, Chinese government officials have publicly promoted FDI by promising market access expansion to foreign investors, stronger national treatment of foreign firms, and the strengthening of China’s legal and regulatory frameworks to enhance market-based competition.

Despite assurances of market access and small modifications to the FIC that liberalized a handful of new sectors, FDI growth in China remained relatively flat in 2017. According to Chinese official statistics, FDI in 2017 was USD 131 billion, a less than four percent increase from the prior year. Despite static FDI growth in the past few years, China still is one of the largest recipients of FDI due to its sustained high economic growth rate, growing middle class, and the expansion of consumer demand for diverse products.

In addition to market access concerns, China’s willingness to offer a level playing field for foreign companies is often in question. Foreign investors voice concerns over China’s current investment climate, including: broad use of industrial policies to protect domestic firms through subsidies, preferential financing, and selective legal and regulatory enforcement; weak protection and enforcement of IPR; corruption; discriminatory and non-transparent anti-monopoly enforcement that forces companies to license technology at below-market prices to Chinese competitors; excessive cybersecurity data localization and data-flow requirements; increased emphasis on requirements to include CCP cells in foreign enterprises; and an unreliable legal system lacking transparency and rule of law. Other laws and regulations, including the 2015 Anti-Terrorism Law and the Cyber Security Law, impede local Chinese firms from purchasing foreign-origin technology, raising concerns that China has back-tracked on reforms to further open up to foreign investment.

China promotes FDI through the MOFCOM “Invest in China” website (www.fdi.gov.cn). MOFCOM publishes laws and regulations, economic statistics, investment projects, relevant news articles, and other relevant information about investing in China. In addition, each province has a provincial-level investment promotion agency that operates through local MOFCOM departments.

Limits on Foreign Control and Right to Private Ownership and Establishment

The FIC governs the “pre-establishment,” or market access, phase of foreign investment by listing particular economic sectors or industries as “encouraged”, “restricted”, or “prohibited” when it comes to foreign investment. In June 2017, the Chinese government rebranded the FIC as a “nationwide negative list” by moving economic sectors subject to equity caps, joint ventures requirements, and shareholder rights restrictions in the “encouraged” section to the “restricted” section. The “encouraged” list reflects Chinese sector-specific industrial policy goals. The “restricted” and “prohibited” lists have been combined and renamed the “nationwide negative list” and include industries and economic sectors that are seen as sensitive, possibly touching on national security concerns, or at odds with the industrial goals of China’s economic development plans. In June 2018, China implemented a nationwide negative list that removed “encouraged” investments and restructured the negative list by industry. Instead of maintaining a “restricted” and “prohibited” separate list, all restrictions/prohibitions are now together by industry. Foreign investors interested in industries not on the negative list are no longer required to obtain pre-approval from MOFCOM, but only need to register their investment.

The 2017 Foreign Investment Catalogue made minor liberalizations in manufacturing (rail transportation equipment, automobile equipment, civilian satellites, processing of seeds and other food goods), services (operation of highway transport, ocean shipping, credit rating, accounting/auditing), and mining (exploration of non-conventional gas and oil, precious metals, and smelting of some rare earths) sectors. While modest liberalizations were welcomed by U.S. businesses, many foreign investors were underwhelmed and disappointed by the lack of ambition on market access liberalization, pointing out new openings mainly were in industries that domestic Chinese companies already dominate.

The June 2018 revision of the FIC (i.e., implementation of the nationwide negative list) saw substantial market openings, most of which were previously announced. These included: eliminating equity caps for specialty and new energy vehicles, shipbuilding, and aircraft manufacturing, with a five-year plan to phase out equity caps in other automotive categories, including commercial vehicles by 2020 and passenger vehicles by 2022 (announced April 2018); and some openings in financial services and insurance industry segments, including by raising foreign ownership caps to 51 percent, and thus, allowing majority foreign ownership (announced November 2017).

In the “restricted” category of the FIC, certain industries require joint ventures, impose control requirements requiring that an investment is led by a Chinese national, and apply specific equity caps. Below are some examples, but not an exhaustive list, of investment restrictions:

Preschool, general high school, and higher education institutes (which are also required to be led by a Chinese partner);

Production of radio and television programming and movies;

General Aviation companies for forestry, agriculture, and fisheries;

Market investigations;

Establishment of medical institutions; and

Commercial and passenger vehicle manufacturing.

Examples of foreign investments requiring Chinese control include:

Water transport companies (domestic);

The construction and operation of civilian airports;

The construction and operation of nuclear power plants;

The establishment and operation of cinemas;

Selection and cultivation of new varieties wheat and corn seeds; and

Public air transportation companies.

Examples of foreign investment equity caps include:

50 percent in value-added telecom services (excepting e-commerce);

49 percent in basic telecom enterprises;

51 percent in life insurance firms;

51 percent in security investment fund management companies; and

50 percent in manufacturing of commercial and passenger vehicles.

These investment restrictions often force foreign investors to transfer technology to Chinese partners as a prerequisite to market access, providing Chinese stakeholders tremendous benefit. While such practices are explicitly against WTO rules, foreign companies have reported that in many sectors, these dictates and decisions are made behind closed doors and are thus difficult to attribute as official policies of the Chinese government. In addition, the approval process for foreign investment remains non-transparent with regards to licensing and other approval steps, giving broad discretion to Chinese authorities to impose deal-specific conditions beyond written legal requirements, in a blatant effort to support industrial policy goals that bolster the technological capabilities of local competitors.

Other Investment Policy Reviews

Organization for Economic Cooperation and Development (OECD)

China is not a member of the OECD. The OECD Council decided to establish a country program of dialogue and co-operation with China in October 1995. The most recent OECD Investment Policy Review for China was completed in 2008. The OECD Investment Policy Review noted that policy changes in China between 2006 and 2008 tightened restrictions on inward direct investment, including cross-border mergers and acquisitions (M&As).

In 2013, OECD published a working paper entitled “China Investment Policy: An Update,” which provided an update on China’s investment policy since the publication of the 2008 Investment Policy Review. The paper noted that, although China’s economic strength buoys foreign investor confidence, fears of investment protectionism are growing.

China became a member of the WTO in 2001. WTO membership boosted China’s economic growth and advanced its legal and governmental reforms. The sixth and most recent WTO Investment Trade Review for China was completed in 2016. The report highlighted key changes between the 2011 and 2015 FICs. In addition, it noted that the foreign investment pilot negative list expanded from the Shanghai Pilot FTZ to the FTZs of Tianjin, Fujian, and Guangdong. The trade review also said that China encourages inward FDI, as well as joint ventures between Chinese and foreign companies, particularly in research and development. The report further mentioned that technology transfer, while not a requirement for investment approval, is a practice widely encouraged by Chinese authorities.

Registering a business in China can be difficult. The World Bank ranked China 78th out of 190 economies in terms of ease of doing business and 93rd for starting a business. In Shanghai and Beijing, at least 11 procedures are required to establish a business, with an average timeline of more than 30 days to complete the registration process. Steps to register a business include pre-approval for a company name, a business license approved by the State Administration for Industry and Commerce (SAIC), an organization code certificate with the Quality and Technology Supervision Bureau, registration with the provincial and local tax bureaus, a company seal issued by the police department, registration with the local statistics bureau, a local bank account, the authorization to print or purchase invoices and receipts, and registration with the Ministry of Human Resources and Social Security, as well as with the Social Welfare Insurance Center.

The Government Enterprise Registration (GER), an initiative of the United Nations Conference on Trade and Development (UNCTAD), gave China a score of 1.5 out of 10 on its website for registering and obtaining a business license. SAIC is the main government body that approves business licenses, and according to GER, SAIC’s website lacks even basic information, such as what to do and how to do it.

The State Council in recent years has reduced red tape by eliminating hundreds of administrative licenses and delegating administrative approval power across a range of sectors. The number of investment projects subject to central government approval has reportedly dropped more than 75 percent. The State Council also has set up a website in English, which is more user-friendly than SAIC’s website, to help foreign investors looking to do business in China.

The Department of Foreign Investment Administration within MOFCOM is responsible for foreign investment promotion in China, including promotion activities, coordinating with investment promotion agencies at the provincial and municipal levels, engaging with international economic organizations and business associations, and conducting research related to foreign direct investment into China. MOFCOM also maintains the “Invest in China” website.

Despite recent efforts by the Chinese government to streamline business registration procedures, foreign companies still complain about the challenges they face when setting up a business, including registration and licensing problems. In addition, U.S. companies complain they are treated differently from domestic companies when setting up an investment, which is an added market access barrier for U.S. companies. Numerous companies offer consulting, legal, and accounting services for establishing wholly foreign-owned enterprises, partnership enterprises, joint ventures, and representative offices. The differences among these corporate entities are significant, and investors should review their options carefully with an experienced advisor before choosing a particular corporate entity or investment vehicle.

Outward Investment

China has a relatively new history with outbound investment. In 2001, China initiated its “going-out” investment strategy that encouraged SOEs to go abroad and acquire primarily energy investments that helped facilitate greater market access for Chinese exports to foreign markets. As Chinese investors gained experience, and as China’s economy grew and diversified, China’s outbound investment strategy also changed to include both state and private enterprise investments in multiple economic sectors. China now is one of the largest outward direct investors in the world. While China has reported a decrease in outbound investment in 2017 compared to record-setting investments levels in 2016, some third-party data suggest actual global outbound investment figures in 2017 were on par with 2016 global investment levels. Experts who track investment flows from China noted that while the United States was one of the top investment destinations of Chinese investors in 2017, outbound investment to the United States decreased almost 50 percent in 2017 compared to 2016 numbers. However, experts estimate that outbound investment to Europe and in Asian countries around the “Belt and Road” (described further below) increased.

In August 2017, in reaction to concerns about capital outflows and exchange rate volatility, the Chinese government issued guidance to curb “irrational” outbound investments and created “encouraged,” “restricted,” and “prohibited” investment categories to guide Chinese outbound investment. The guidelines restrict Chinese outbound investment in sectors like property, hotels, cinemas, entertainment, sports teams, and “financial investments that create funds that are not tied to specific investment projects.” The guidance encouraged outbound investment in sectors that supported industrial policy, such as Strategic Emerging Industries (SEI) and MIC 2025, by acquiring advanced manufacturing and high-technology assets. MIC 2025’s main aim is to transform China into an innovation-based economy that can better compete against advanced economies in 10 key high-tech sectors, including: new energy vehicles, next-generation IT, biotechnology, new materials, aerospace, oceans engineering and ships, railway, robotics, power equipment, and agriculture machinery. Chinese firms in MIC 2025 industries often receive preferential treatment such as preferred financing, subsidies, and access to an opaque network of investors to promote and provide incentives for outbound investment in key sectors. The outbound investment guidance also encourages investments that promote China’s Belt and Road development strategy that seeks to create connectivity and cooperation agreements between China and countries along the Chinese designated “Silk Road Economic Belt and the 21st-century Maritime Silk Road” through an expansion of infrastructure investment, construction materials, real estate, power grids, etc.

2. Bilateral Investment Agreements and Taxation TreatiesShare

Bilateral Investment Treaties (BITs) or Free Trade Agreements (FTAs)

China has 109 BITs currently in force and multiple FTAs with an investment chapter. These agreements cover expropriation, most-favored-nation treatment, and repatriation of investment proceeds, and provide for arbitration. China’s agreements are generally regarded as weaker than the BITs and FTA investment chapters that the United States seeks to negotiate.

The United States and China were actively engaged in BIT negotiations from October 2012 until January 2017. China is currently in negotiations with the European Union (EU), and both jointly announced that market access offers would be exchanged at the EU-China Summit in July 2018.

In addition to BITs, China also has 17 FTAs with its trade and investment partners. It is currently negotiating an additional 11 FTAs and researching 11 more potential FTAs. China’s existing FTA partners are Maldives, Georgia, ASEAN, Republic of Korea, Pakistan, Australia, Singapore, Pakistan, New Zealand, Chile, Peru, Costa Rica, Iceland, Switzerland, Hong Kong, Macao, and Taiwan. China concluded its FTAs with Maldives and Georgia in 2017.

The United States and China concluded a bilateral taxation treaty in 1984.

3. Legal RegimeShare

Transparency of the Regulatory System

The World Bank assessed China’s regulatory governance by providing a composite score of 2 out 6 points. The World Bank attributes the relatively low score to the futility of foreign companies appealing administrative authorities’ decisions, given impartial courts, not having laws and regulations in one accessible place that is updated regularly, the lack of impact assessments conducted prior to issuing a new law, and other concerns about public comments and transparency.

U.S. businesses consistently rank arbitrary legal enforcement and the lack of regulatory transparency among the top challenges of doing business in China. China’s legal and regulatory systems are complex and allow regulators and government authorities broad discretion to enforce regulations, rules, and other regulatory guidelines in an inconsistent and impartial manner. Government-controlled trade organizations, business associations, and regulatory bodies set industry standards that often are inconsistent with international norms and best practices and directly benefit Chinese competitors, while simultaneously allowing regulators to ignore Chinese transgressors but strictly enforce regulations targeting foreign companies. In addition to central and provincial-level rules and guidelines that impact foreign businesses and investors, there are also administrative rules and enforcement guidelines, which are not necessarily part of the legal code or even published. The complex regulatory system and unpublished enforcement guidelines overly burden foreign investors and foreign companies that must confront a regulatory system rife with contradictions and inconsistencies. A lack of confidence in the regulatory system and overall confusion is a common complaint of U.S. businesses operating in the local Chinese business environment.

To comply with China’s WTO accession commitments, the State Council’s Legislative Affairs Office (SCLAO) has issued instructions to Chinese agencies to publish all foreign trade and investment-related laws, regulations, rules, and policy measures in the MOFCOM Gazette. The State Council also issued Interim Measures on Public Comment Solicitation of Laws and Regulations and the Circular on Public Comment Solicitation of Department Rules, which require government agencies to post proposed trade and economic-related administrative regulations and departmental rules on the official SCLAO website for a 30-day public comment period. Despite these commitments, Chinese agencies often do not meet the WTO commitments. Chinese ministries under the State Council continue to post only some of the draft administrative regulations and departmental rules on the SCLAO website; even when drafts are published, they often are available for comment for less than the required 30 days.

The State Council and the ministries under the State Council also issue “normative documents” (opinions, circulars, notices, etc.), which are quasi-regulations used to implement applicable rules, laws, and regulations and to address legal specificity problems or situations where there is no governing law. These documents typically are not available for public comment and sometimes are not even published, yet the U.S. business community reports that Chinese ministries impose requirements on companies by referencing these normative documents.

Proposed draft regulations are often drafted without using scientific studies or quantitative analysis to assess the regulation’s impact. When Chinese officials claim an assessment was made, the methodology of the study and the results are not made available to the public. When draft regulations are available for public comment, it is unclear what impact third-party comments have on the final regulation. The lack of transparency in regulation drafting only adds to foreign investor perceptions that industrial policy goals and other anti-competitive factors are the driving forces behind China’s regulatory regime.

The inability to separate the relationships between the CCP, the Chinese government, Chinese businesses, and other stakeholders in the domestic economy makes it impossible to determine the motivating factors behind state actions. As a result, many foreign-invested companies perceive that Chinese government officials prioritize political goals, industrial policies, and a desire to protect social stability at the expense of foreign investors. An example of these blurred lines is evident with Chinese Self-Regulatory Organizations (SROs) that are responsible for licensing decisions. For instance, a Chinese financial institution may be a voting member, and can exert tremendous influence upon, the same SRO that adjudicates the license application of a foreign competitor. To protect one’s market share and competitive position, a Chinese company has incentive to disapprove the license application. The licensing procedures, because of the blurred lines, are non-transparent, discriminatory, and erode the rule of law.

Access to foreign online resources – including news, cloud-based business services, and virtual private networks (VPNs) – are increasingly restricted without official acknowledgement or explanation. Foreign-invested companies have also reported threats of retaliation by government regulators for actions taken by the United States and other foreign governments at the WTO or other legal forums.

For accounting standards, Chinese companies must use the Chinese Accounting Standards for Business Enterprises (ASBE) for all financial reporting within mainland China. Companies listed overseas (including in Hong Kong) may choose to use ASBE, the International Financial Reporting Standards, or Hong Kong Financial Reporting Standards.

International Regulatory Considerations

China has been a member of the WTO since 2001. As part of its accession agreement, China agreed to notify the WTO Committee on Technical Barriers to Trade of all draft technical regulations. Compliance with this WTO commitment is something Chinese officials have promised in previous dialogues with U.S. government officials.

Legal System and Judicial Independence

The Chinese legal system is based on a civil law model that borrowed heavily from the legal systems of Germany and France, but retains local Chinese legal characteristics. The rules governing commercial activities are present in various laws, regulations, and judicial interpretations, including China’s civil law, contract law, partnership enterprises law, security law, insurance law, enterprises bankruptcy law, labor law, and Supreme People’s Court (SPC) Interpretation on Several Issues Regarding the Application of the Contract Law. While China does not have specialized commercial courts, in 2014, three IP courts were established in Beijing, Guangzhou, and Shanghai.

While China’s Constitution and various laws provide a legal basis for court independence, or the exercise of adjudicative power free from interference by administrative organs, public organizations, and/or powerful individuals, in practice, courts are heavily influence by Chinese regulators and the CCP. The Chinese Constitution also emphasizes the “leadership of the Communist Party,” which has only been strengthened by consolidation of political power by China’s senior-most leaders at the end of 2017. The reasons for interference may include:

Courts fall under the jurisdiction of local governments;

Court budgets are appropriated by local administrative authorities;

Judges in China have administrative ranks and are managed as administrative officials;

The CCP is in charge of the appointment, dismissal, transfer, and promotion of administrative officials;

China’s Constitution stipulates that local legislatures appoint and supervise the courts; and

Corruption may also influence local court decisions.

The U.S. business community consistently reports that Chinese courts, particularly at lower levels, are susceptible to outside political influence (particularly from local governments), lack the sophistication to understand complex commercial disputes, and operate without transparency. U.S. companies often avoid challenging administrative decisions or bringing commercial disputes before a local court for fear of future retaliation.

Reports of business disputes involving violence, death threats, hostage-taking, and travel bans involving Americans continue to be prevalent, although American citizens and foreigners in general do not appear to be more likely than Chinese nationals to be subject to this treatment. Police are often reluctant to intervene in what they consider internal contract disputes.

Laws and Regulations on Foreign Direct Investment

China’s foreign direct investment legal and regulatory frameworks have more across-the-board foreign investment restrictions and less transparency than developed countries, including the United States. Broad investment restrictions at both the central and local level lead to inconsistent enforcement of foreign investment laws and add to the difficulty of gaining necessary approvals from different agencies and localities. In turn, all of this adds to a feeling among U.S. investors that the Chinese legal system discriminates against them.

China’s central-level foreign investment regime consists of three laws: the China-Foreign Equity Joint Venture Enterprise Law, the China-Foreign Cooperative Joint Venture Enterprise Law, and the Foreign-Invested Enterprise (FIE) Law. In addition, there are multiple administrative regulations and regulatory documents issued by the State Council that are directly derived from these three laws, including:

Local legislatures and governments also enact their own regulations, rules, and guidelines that directly impact foreign investment in their geographical area. Examples include the Wuhan Administration Regulation on Foreign-Invested Enterprises and Shanghai’s Municipal Administration Measures on Land Usage of Foreign-Invested Enterprises.

Foreign investments in industries and economic sectors that are not listed in the “restricted” or “prohibited” sections of the FIC are not subject to MOFCOM pre-approval, but only require notification of the proposed investment. However, wanting to invest in a category that is not restricted or prohibited does not guarantee approval, as other steps and approvals are required in order to proceed, including, for example, receiving land rights, business licenses, and other necessary permits. In some industries, such as telecommunications, foreign investors will also need to receive approval from regulators like the Ministry of Industry and Information Technology (MIIT).

In July 2004, the State Council issued the Decision on Investment Regime Reform and the Catalogue of Investment Projects subject to Government Ratification (Ratification Catalogue). According to the Ratification Catalogue, all proposed foreign investment projects in China must be submitted for “review and ratification” by the NDRC, or provincial or local Development and Reform Commissions (DRCs), depending on the sector and value of the investment. In 2013, however, the government issued a new catalogue to narrow the scope of foreign investment projects subject to NDRC ratification. Per the updated guidance, an “encouraged” investment under the FIC that does not require a Chinese controlling interest, and is in a sector not listed on the Ratification Catalogue, only needs to be “filed for record” with the local DRC office. This policy shift marked a positive step toward easing bureaucratic barriers to foreign investment.

In November 2014, China released an updated edition of the Ratification Catalogue, which eliminated NDRC ratification requirements for 15 new sectors and delegated ratification authority to local governments in 23 additional sectors. In several new sectors, the new Ratification Catalogue also raised the threshold of foreign ownership that would trigger the requirement for NDRC approval. When announcing the reforms, NDRC stated the goal of the latest revision to the Ratification Catalogue was to limit ratification to projects relating to “national and ecological security, geographic and resource development,” and the “public interest.” NDRC estimates that revisions made to the Ratification Catalogue over the past several years will reduce the number of projects requiring ratification from central government authorities by 76 percent.

The NDRC approval process for foreign investment projects also includes assessing the project’s compliance with China’s laws and regulations; its compliance with the FIC and industrial policy; its national security, environmental safety, and public interest implications; its use of resources and energy; and its economic development ramifications. In some cases, NDRC also solicits the opinions of relevant Chinese industrial regulators and “consulting agencies,” which may include industry associations that represent Chinese domestic firms. This presents potential conflicts of interest that can disadvantage foreign investors seeking to receive project approval. The State Council may also weigh in on high-value projects in “restricted” sectors.

After receiving NDRC approval for the investment project and either notifying or applying for approval for an investment from MOFCOM, investors next apply for a business license with the SAIC. Once a license is obtained, the investor registers with China’s tax and foreign exchange agencies. Greenfield investment projects must also seek approval from China’s Environmental Protection Ministry and its Ministry of Land Resources. The specific approvals process may vary from case to case, depending on the details of a particular investment proposal and local rules and practices.

For investments made via merger or acquisition with a Chinese domestic enterprise, an anti-monopoly review and national security review may be required by MOFCOM if there are concerns about the foreign transaction. The anti-monopoly review is detailed in a later section of this report, on competition policy.

Article 12 of MOFCOM’s Rules on Mergers and Acquisitions of Domestic Enterprises by Foreign Investment stipulates that parties are required to report a transaction to MOFCOM if:

The merger or acquisition affects or may affect “national economic security”; or

The merger or acquisition would cause the transfer of actual control of a domestic enterprise with a famous trademark or a Chinese time-honored brand.

If MOFCOM determines the parties did not report a merger or acquisition that affects or could affect national economic security, it may, together with other government agencies, require the parties to terminate the transaction or adopt other measures to eliminate the impact on national economic security. In February 2011, China released the State Council Notice Regarding the Establishment of a Security Review Mechanism for Foreign Investors Acquiring Domestic Enterprises. The notice established an interagency Joint Conference, led by NDRC and MOFCOM, with authority to block foreign M&As of domestic firms that it believes may impact national security. The Joint Conference is instructed to consider not just national security, but also “national economic security” and “social order” when reviewing transactions. China has not disclosed any instances in which it invoked this formal review mechanism.

Local commerce departments are responsible for flagging transactions that require a national security review when they review them in an early stage of China’s foreign investment approval process. Some provincial and municipal departments of commerce have published online a Security Review Industry Table listing non-defense industries where transactions may trigger a national security review, but MOFCOM has declined to confirm whether these lists reflect official policy. In addition, third parties such as other governmental agencies, industry associations, and companies in the same industry can seek MOFCOM’s review of transactions, which can pose conflicts of interest that disadvantage foreign investors. Investors may also voluntarily file for a national security review.

In January 2015, MOFCOM issued for public comment a new Foreign Investment Law. This law, if enacted, would unify and supersede the three governing foreign investment laws established by the State Council. It also would abolish the case-by-case approval system for foreign investment and replace it with a system that gives foreign investors “national treatment,” or treats foreign investors the same as domestic investors, except in the limited number of industries enumerated on the “negative list.” The draft law called for streamlining the approval process for foreign investment in some sectors, but contains a number of troubling provisions – e.g., broadening the definition of foreign investor, expanding the role of the national security review mechanism, increasing reporting requirements, and threatening the structure of variable interest entities (VIEs) – that could facilitate discriminatory treatment against foreign investment. In addition to transforming the current foreign investment regime, the aforementioned MOFCOM draft Foreign Investment Law would also establish a broad and potentially intrusive national security review mechanism. As it is currently envisaged, the national security review could be used to hinder market access and increase the financial burden of foreign investment in China. While Chinese officials have noted future plans for a unified foreign investment law, the timeline and the content of the new law is unclear.

China also issued in 2015 the Interim Measures on the National Security Review of Foreign Investment in Free Trade Zones. The definition of “national security” is broad, implicating investments in military, national defense, agriculture, energy, infrastructure, transportation, culture, information technology products and services, key technology, and manufacturing.

In addition, MOFCOM issued the Administrative Measures for the Record-Filing of Foreign Investment in Free Trade Zones, outlining the streamlined process that foreign investors need to follow to register investments in the FTZs.

Competition and Anti-Trust Laws

China uses a complex system of laws, regulations, and agency specific guidelines at both the central and provincial levels that impacts an economic sector’s makeup, sometimes as a monopoly, near-monopoly, or authorized oligopoly. These measures are particularly common in resource-intensive sectors such as electricity and transportation, as well as in industries seeking unified national coverage like fixed-line telephony and postal services. The measures also target sectors the government deems vital to national security and economic stability, including defense, energy, and banking. Examples of such laws and regulations include the Law on Electricity (1996), Civil Aviation Law (1995), Regulations on Telecommunication (2000), Postal Law (amended in 2009), Railroad Law (1991), and Commercial Bank Law (amended in 2003), among others.

Anti-Monopoly Law

China’s Anti-Monopoly Law (AML) went into effect on August 1, 2008. The AML delegates antitrust enforcement to three agencies: MOFCOM to review concentrations (M&As); the NDRC to review cartel agreements, abuse of dominant position, and abuse of administrative powers centered on product pricing; and the SAIC to review the same types of activities as NDRC when those activities are not directly price-related. In addition, the AML established the Anti-Monopoly Commission to provide oversight, expertise, and coordination among different stakeholders and enforcement agencies. After the AML was enacted, the need to clarify parts of the law became apparent, leading MOFCOM, NDRC, SAIC, and other Chinese government ministries and agencies to formulate implementing guidelines, departmental rules, and other measures. Generally, the AML enforcement agencies have sought public comment on proposed measures and guidelines, although comment periods can be less than 30 days.

During the National People’s Congress (NPC) in March 2018, the CCP announced that the three AML agencies would be consolidated under the newly-established State Administration for Market Regulation (SAMR). Details and timelines for this new announcement have not yet been provided.

In 2016, the three AML enforcement agencies drafted guidelines on six enforcement areas: anti-monopoly guidelines for the automobile industry, guidelines on determining illegal incomes and fines, guidelines on the “leniency” system in horizontal monopoly agreements, guidelines on AML settlement cases, guidelines for IP abuse, and guidelines on monopolistic agreement exemptions. While these guidelines may provide greater clarity and business predictability for foreign investment, they have yet to be finalized by the State Council.

In addition, the State Council in June 2016 issued guidelines for the Fair Competition Review Mechanism that targets administrative monopolies created by government agents, primarily at the local level. The mechanism not only requires government agencies to conduct a fair competition review prior to issuing new laws, regulations, and guidelines, to certify that proposed measures do not inhibit competition, but also requires government agencies to conduct a review of all existing rules, regulations, and guidelines, to eliminate existing laws and regulations that are competition inhibiting. In October 2017, the State Council, SCLAO, Ministry of Finance, and three AML agencies issued implementation rules for the fair competition review system to strengthen review procedures, provide review criteria, enhance coordination among government entities, and improve overall competition-based supervision in new laws and regulations. While it is too early to estimate the impact of the mechanism on competition and in breaking up administrative monopolies, Chinese academics in particular are optimistic that this development signals a more prominent role for competition in future economic decisions.

While procedural developments such as those outlined above are seen as generally positive, the actual enforcement of competition laws and regulations is uneven. Inconsistent central and provincial enforcement of antitrust law often exacerbates local protectionism by restricting inter-provincial trade, limiting market access for certain imported products, using measures that raise production costs, and limiting opportunities for foreign investment. Government authorities at all levels in China may also restrict competition to insulate favored firms from competition through various forms of regulations and industrial policies. The ultimate benefactor of such policies is often unclear; however, foreign companies have expressed concern that the central government’s use of AML enforcement is often selectively used to target foreign companies, becoming an extension of other industrial policies that favor SOEs and Chinese companies deemed potential “national champions.”

MOFCOM currently is responsible for M&A review. However, with the reorganization of AML enforcement now under SAMR, a new division within SAMR will take over M&A review in 2018. Since the AML went into effect, the number of M&A transactions MOFCOM has reviewed each year has continued to grow. U.S. companies and other observers have expressed concerns that MOFCOM needs to consult with other agencies when reviewing a potential transaction and that other agencies can raise concerns that are not related to competition to either block, delay, or force one or more of the parties to comply with a condition in order to receive MOFCOM approval. There is also suspicion that Chinese regulators rarely approve “on condition” transactions involving two Chinese companies, thus signaling an inherent AML bias against foreign enterprises.

The NDRC has made some procedural progress in AML enforcement on price-related cases by releasing aggregate data on investigations and publicizing case decisions. However, many U.S. companies complain that NDRC discourages companies from having legal representation during informal discussions or formal investigations and that the investigative process lacks transparency or specific guidance on evidence gathering or other practices. Observers also worry about future “dawn raids” and express concerns that NDRC regulators, along with the other AML regulators, can at any time use competition law to promote China’s industrial policy goals by targeting foreign firms to limit competition. Observers further worry that despite commitments by Chinese officials to protect commercial secrets obtained during an AML investigation, access to secret and proprietary information could nevertheless be given to a Chinese competitor.

In bilateral dialogues, China continues to express its commitment to protect and enforce IPR across a wide range of industry sectors. While U.S. companies see this as a positive development, there is growing concern on how China handles IPR protection that intersects with antitrust concerns. Enforcement practice, along with the draft guidelines that Chinese officials have issued for public comment on IP abuse, disproportionately impact foreign firms by requiring a company to license IP technology to local competitors, at a “fair price” that does not abuse the company’s “dominant market position.” Foreign companies have long complained that such a view of antitrust serves industrial policy goals to force technology transfer to local competitors under the guise of the AML.

Another consistent area of concern from foreign companies is how the AML applies to SOEs and other government monopolies permitted in some industries. All three AML enforcement agencies have provided assurance that AML enforcement applies to SOEs, and there have been some AML punitive actions taken by NDRC and SAIC against provincial-level SOEs in recent years. However, the AML explicitly protects the lawful operations of SOEs and government monopolies in industries deemed nationally important. While SOEs have not been entirely immune from AML investigations, when considering the number of SOE investigations compared to the role SOEs play in China’s economy, the numbers are not commensurate. The CCP’s proactive orchestration of mergers and consolidation of SOEs in industries like rail, marine shipping, metals, and other strategic sectors, which in most instances only further insulates SOEs from both private and foreign competition, signals that enforcement against SOEs will remain limited despite potential negative impacts on consumer welfare.

Expropriation and Compensation

Chinese law prohibits nationalization of foreign-invested enterprises, except under “special circumstances.” Chinese officials have said these circumstances may include when there is a national security component or when an investment presents an obstacle to achieving a large civil engineering project. However, Chinese law does not define what special circumstances would lead to nationalization of a foreign investment. Chinese law, while requiring compensation of expropriated foreign investments, does not say what method or formula to use to calculate the value of the foreign investment. The Department of State is not aware of any cases since 1979 in which China has expropriated a U.S. investment, although the Department has notified Congress through the annual 527 Investment Dispute Report of several cases of concern.

Dispute Settlement

ICSID Convention and New York Convention

China is a contracting State to the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (ICSID Convention) and has ratified the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention). The domestic legislation that provides for enforcement of foreign arbitral awards related to these two Conventions includes the Arbitration Law adopted in 1994, the Civil Procedure Law adopted in 1991 (later amended in 2012), the Law on Chinese-Foreign Equity Joint Ventures adopted in 1979 (amended most recently in 2001), and a number of other laws with similar provisions. China’s Arbitration Law has embraced many of the fundamental principles of The United Nations Commission on International Trade Law’s Model Law on International Commercial Arbitration.

International Commercial Disputes and the Chinese Legal System

Chinese officials typically urge private parties to resolve commercial disputes through informal conciliation. If formal mediation is necessary, Chinese parties and the authorities typically promote arbitration over litigation. Many contract disputes require arbitration by the Beijing-based China International Economic and Trade Arbitration Commission (CIETAC). Established by the State Council in 1956 under the auspices of the China Council for the Promotion of International Trade (CCPIT), CIETAC is China’s most widely-utilized arbitral body for foreign-related disputes. Some foreign parties have obtained favorable rulings from CIETAC, while others question CIETAC’s fairness and effectiveness.

CIETAC also had four sub-commissions located in Shanghai, Shenzhen, Tianjin, and Chongqing. In 2012, CCPIT, under the authority of the State Council, issued new arbitration rules that granted CIETAC headquarters significantly more authority to hear cases than the sub-commissions; CIETAC Shanghai and CIETAC Shenzhen then declared their independence from the Beijing authority and issued their own rules and changed their name. As a result, CIETAC disqualified its former Shanghai and Shenzhen affiliates from administering arbitration disputes. This jurisdictional dispute between CIETAC in Beijing and the former sub-commissions raised serious concerns among the U.S. business and legal communities, particularly regarding the validity of arbitration agreements specifying particular arbitration procedures and the enforceability of arbitral awards issued by the sub-commissions. In 2013, the SPC issued a notice clarifying that any lower court that hears a case arising out of the CIETAC split must report the case to the SPC before making a decision. However, the SPC notice is brief and lacks detail on certain issues, including the timeframe for the lower court’s decision to reach the SPC and for the SPC to issue its opinion.

There are also many provincial and municipal arbitration commissions, like the Beijing Arbitration Commission and the Shanghai Arbitration Commission, that have emerged as serious domestic competitors to CIETAC. A foreign party may seek arbitration from an offshore commission. Foreign companies often encounter challenges in enforcing arbitration decisions issued by Chinese and foreign arbitration bodies. In these instances, foreign investors may appeal to higher courts in such cases.

The Chinese government and judicial bodies do not maintain a public record of investment disputes. The SPC maintains a count of the annual number of cases involving foreigners tried in China, but does not specify the types of cases, identify civil or commercial disputes, or note foreign investment disputes. Rulings in some cases are open to the public.

International Commercial Arbitration and Foreign Courts

The recognition and enforcement of judgments issued by foreign courts in the Chinese court system is governed by Articles 281 and 282 of the Civil Procedural Law. The law states that a Chinese court must review China’s treaty obligations, reciprocity principles, basic Chinese law, Chinese sovereignty, Chinese social and public interests, and national security before determining if the validity of a judgment from a foreign court should be recognized. As a result, there are few examples of a Chinese court recognizing and enforcing a foreign court judgment, and China’s recognition of U.S. court judgments has been inconsistent, according to anecdotal reports. China has concluded 27 bilateral agreements on the recognition and enforcement of foreign court judgments, but none with the United States.

Article 270 of China’s Civil Procedure Law states that time limits in civil cases do not apply to cases involving foreign investment. According to the 2012 CIETAC Arbitration Rules, in an ordinary procedure case, the arbitral tribunal shall render an arbitral award within six months (in foreign-related cases) from the date on which the arbitral tribunal is formed. In a summary procedure case, the arbitral tribunal shall make an award within three months from the date on which the arbitral tribunal is formed.

Bankruptcy Regulations

China’s primary bankruptcy legislation is the Enterprise Bankruptcy Law, which was promulgated on August 27, 2006, and took effect on June 1, 2007. The 2007 law applies to all companies incorporated under Chinese laws and regulations, including private companies, public companies, SOEs, foreign invested enterprises (FIEs), and financial institutions. It is commensurate with developed countries’ bankruptcy laws and provides for potential reorganization or restructuring, rather than liquidation. Due to uncertainty about authorities and procedures, lack of implementation guidelines, and the limited number of cases providing precedent, the law has never been fully enforced, and most corporate debt disputes are settled through negotiations led by local governments. Companies are disincentivized from pursing bankruptcy because of the potential of local government interference and fear of losing control. Chinese courts lack capacity to handle bankruptcy cases, and bankruptcy administrators, clerks, and judges all lack experience.

In the October 2016 State Council Guiding Opinion on Reducing Enterprises’ Leverage Ratio, bankruptcy was identified as a tool to manage China’s corporate debt problems. This was consistent with increased government rhetoric throughout the year in support of bankruptcy. For example, in June 2016, the SPC issued a notice to establish bankruptcy divisions at intermediate courts and to increase the number of judges and support staff to handle liquidation and bankruptcy issues. On August 1, the SPC also launched a new bankruptcy and reorganization electronic information platform: http://pccz.court.gov.cn/pcajxxw/index/xxwsy.

The number of bankruptcy cases has continued to grow since 2015. The SPC reported that in 2017, 9,542 bankruptcy cases were accepted by the Chinese courts, representing a 68.4 percent year-on-year increase from 2016, and 6,257 cases were closed, representing a 73.7 percent year-on-year increase from 2016. The SPC has continued to issue clarifications and new implementing measures to improve bankruptcy procedures.

4. Industrial PoliciesShare

Investment Incentives

Different localities craft preferential packages like reduced income taxes, resources and land use benefits, reduced import/export duties, special treatment in obtaining basic infrastructure services, streamlined government approvals, and funding for initial startup to attract foreign investment. Often, these packages will stipulate that a foreign investor must meet certain export, local content, technology transfer, and other requirements as part of the preferred investment package. Preferential treatment often occurs in special economic zones (like the 11 FTZs), development zones, and science parks, usually in specific sectors that the government has identified for policy support, like technology and advanced manufacturing. China’s central government made a concentrated effort in 2017 to promote preferential packages in inland areas, which was the main impetus for adding seven new FTZs in 2017 in inland areas in need of economic development, especially greater foreign investment in Central and Western China. China also uses a more liberalized Catalogue of Priority Industries for Foreign Investment in Central and Western China to provide greater market access to foreign investors willing to invest in inland areas of mainland China.

There are no express prohibitions against foreign firms participating in research and development programs financed by the Chinese government. In fact, Chinese officials have publicly pledged foreign investors equal access to preferential policies under the MIC 2025 initiative to help China transform its economy to an innovation-based economy. In these high-tech and advanced manufacturing sectors, China needs foreign investment because it lacks the capacity, expertise, and technological know-how to conduct advanced research or manufacture advanced technology in innovation-driven industries. China’s MIC 2025 roadmap includes targets for the following industries: new-generation information technology, advanced numerical-control machine tools and robotics, aerospace equipment, maritime engineering equipment and vessels, advanced rail, new-energy vehicles, electricity equipment, agriculture, new materials, and biopharmaceuticals and medical equipment. Foreign investment plays an important role in helping China move up the manufacturing value chain. However, there are a large number of economic sectors that China deems sensitive due to broadly defined national security concerns, including “economic security,” which can effectively close off foreign investment to those sectors.

Foreign Trade Zones/Free Ports/Trade Facilitation

China’s principal customs-bonded areas include Shanghai, Tianjin, Shantou, three districts within Shenzhen (Futian, Yantian, and Shatoujiao), Guangzhou, Dalian, Xiamen, Ningbo, Zhuhai, and Fuzhou. Besides these official duty-free zones identified by China’s State Council, numerous economic development zones and open cities offer similar privileges and benefits to foreign investors.

In September 2013, the Shanghai Municipal government and the State Council announced the establishment of the Shanghai Pilot FTZ, which condensed four previously existing bonded areas into a single FTZ. In April 2015, the State Council expanded the number of FTZs to include Tianjin, Guangdong, and Fujian, although the Shanghai Pilot FTZ remains the largest of the four. In March 2017, the State Council approved the establishment of seven new FTZs in Chongqing, Henan, Hubei, Liaoning, Shaanxi, Sichuan, and Zhejiang, bring the total FTZs to 11. The stated purpose of the new FTZs is to integrate more closely with the Belt and Road Initiative – the Chinese government’s plan to enhance global economic interconnectivity through joint infrastructure and investment projects that connect China’s inland and border regions to countries in Southeast Asia, Central Asia, Africa, and Europe. The goal of all the FTZs is to provide a trial ground for trade and investment liberalization measures and to introduce service sector reforms, especially in financial services, that China expects to eventually introduce in other parts of the domestic economy.

The FTZs should offer foreign investors “national treatment” for the market access phase of an investment in industries and sectors not listed on the FTZ “negative list,” or list of industries and economic sectors that are restricted or prohibited for foreign investment. The State Council published an updated FTZ negative list in June 2018 that reduced the number of restrictions and prohibitions on foreign investment from 95 items down to 45. The most recent negative list did not remove many commercially significant restrictions or prohibitions compared to the nationwide negative list also released in June 2018.

Although the FTZ negative list in theory provides greater market access for foreign investment in the FTZs, many foreign firms have reported that in practice, the degree of liberalization in the FTZs is comparable to other opportunities in other parts of China. According to Chinese officials, over 18,000 entities have registered in the FTZs. The municipal and central governments have released a number of administrative and sector-specific regulations and circulars that outline the procedures and regulations in the zones.

Performance and Data Localization Requirements

Shortly after China’s WTO ascension, China revised its FDI laws imposing export performance requirements, requirements to include local content, requirements to balance foreign exchange through trade, technology transfer requirements, and requirements to create research and development centers. As part of these revisions, China committed to only enforce technology transfer requirements that do not violate WTO standards on IP and trade-related investment measures. In practice, however, some local officials and regulators prefer investments with “voluntary” performance requirements that develop favored industries and support the local job market. Provincial and municipal governments will sometimes restrict access to local markets, government procurement, and public works projects even for foreign firms that have already invested in the province or municipality. In addition, Chinese regulators have reportedly pressured foreign firms in some sectors to disclose IP content or provide IP licenses to Chinese firms, often at below market rates.

Regulatory restrictions, including in the Cyber Security Law, limit the ability of domestic and foreign operators of “critical information infrastructure” to transfer business and personal data outside of China, while requiring those same operators to store such data in China. Restrictions on cross-border data flows and unclear requirements on the use of domestic encryption algorithms have prompted many firms to review how their China systems interact with their global corporate networks. Foreign firms fear that in order to comply with emerging requirements that technology used by business be “secure and controllable,” they will be pressured to disclose source code and other IP disclosures during testing and certification related to government procurement; adhere to prescriptive technology adoption requirements, often in the form of domestic standards that diverge from global standards, which give preference to domestic firms; and to comply with operational restrictions such as privacy measures, data center location, and cross-border data flow restrictions.

5. Protection of Property RightsShare

Real Property

Foreign companies have long complained that the Chinese legal system, responsible for mediating acquisition and disposition of property, has inconsistently protected the legal real property rights of foreigners.

Land is entirely owned by the State. The State can issue long-term land leases to individuals and companies, including foreigners, subject to many restrictions. China’s Property Law stipulates that residential property rights will renew automatically, while commercial and industrial grants shall be renewed if the renewal does not conflict with other public interest claims. A number of foreign investors have reported that their land use rights were revoked and given to developers to build neighborhoods slated for building by government officials. Investors often complain that compensation in these cases has been nominal.

In rural China, land use rights are more complicated. The registration system chronically suffers from unclear ownership lines and disputed border claims, often at the expense of local farmers who are excluded from the process by village leaders making “handshake deals” with commercial interests. The central government announced in 2016, and reiterated in 2017, plans to reform the rural land registration system so as to put more control in the hands of farmers, but some experts remain skeptical that changes will be properly implemented and enforced.

China’s Securities Law defines debtor and guarantor rights, including rights to mortgage certain types of property and other tangible assets, including long-term leases. Chinese law does not prohibit foreigners from buying non-performing debt, which can only be acquired through state-owned asset management firms. However, in practice, Chinese official often use bureaucratic hurdles that limit foreigners’ ability to liquidate assets, further discouraging foreign purchase of non-performing debt.

Intellectual Property Rights

Following WTO accession, China updated many of its laws and regulations to comply with the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS) and other international agreements. However, there are still aspects of China’s IPR legal and regulatory regime that the U.S. government believes fall short of international best practices and, if improved, would provide greater protection to IPR. Furthermore, effective enforcement of China’s IPR laws and regulations remains a significant challenge.

Generally speaking, criminal penalties imposed by Chinese courts for IPR infringement are not applied on a frequent and consistent enough basis to significantly deter ongoing infringement. Furthermore, when administrative sanctions are issued, the basis for the sanctions is inconsistent and non-transparent, and penalties applied are insignificant, further weakening any deterrent effect. Expansion of China’s specialized IP courts reflects increasing awareness of IPR; however, damage awards remain low, making civil litigation against IPR infringement an option with limited effect. Goods transshipped through China (including Hong Kong) accounted for an estimated 87 percent of IPR-infringing goods seized at U.S. borders. (Note: This U.S. Customs statistic does not specify where the fake goods were made.) China imposes requirements that U.S. firms develop their IP in China or transfer their IP to Chinese entities as a condition to accessing the Chinese market. China also requires that mandatory adverse terms be applied to foreign IP licensors and maintains policies that effectively requires U.S. firms to localize research and development activities, practices documented in the March 2018 Section 301 Report released by the Office of the U.S. Trade Representative (USTR). China remained on the Priority Watch List in the 2018 USTR Special 301 Report, and several Chinese physical and online markets were included in the 2017 USTR Notorious Markets Report. For detailed information on China’s environment for IPR protection and enforcement, please see the following reports:

For additional information about national laws and points of contact at local intellectual property offices, please see the World Intellectual Property Organization’s country profiles at http://www.wipo.int/directory/en.

6. Financial SectorShare

Capital Markets and Portfolio Investment

China’s leadership has stated that it seeks to build a modern, highly developed, and multi-tiered capital market. Bank loans continue to provide the majority of credit options (reportedly around 70 percent) for Chinese companies, although other sources of capital, such as corporate bonds, trust loans, equity financing, and private equity are quickly expanding their scope, reach, and sophistication. Chinese regulators regularly use administrative methods to control credit growth, although market-based tools such as interest rate policy play an increasingly important role.

The People’s Bank of China (PBOC), China’s central bank, has gradually increased flexibility for banks in setting interest rates, formally removing the floor on the lending rate in 2013 and the deposit rate cap in 2015 – but is understood to still influence bank’s interest rates through “window guidance.” Favored borrowers, particularly SOEs, benefit from greater access to capital and lower financing costs, as they can use political influence to secure bank loans, and lenders perceive these entities to have an implicit government guarantee. Small- and medium-sized enterprises, by contrast, have the most difficulty obtaining financing, often forced to rely on retained earnings or informal investment channels.

In the past year, Chinese regulators have taken measures to rein in the rapid growth of China’s “shadow banking” sector, which includes vehicles such as wealth management and trust products. These vehicles often provide private firms additional channels to obtain capital, although at higher than benchmark rates. Chinese authorities have taken steps to increase the transparency requirements and strengthen supervision of these banking activities. In 2017, worried about increasingly interconnected leverage across China’s corporate sector, President Xi Jinping declared China’s financial security to be a matter of national security, and regulators redoubled their efforts to rein in financial sector risks.

Direct financing has expanded over the last few years, including through public listings on stock exchanges, both inside and outside of China, and issuing more corporate and local government bonds. The majority of foreign portfolio investment in Chinese companies occurs on foreign exchanges, primarily in the United States and Hong Kong. In addition, China has significantly expanded quotas for certain foreign institutional investors to invest in domestic stock markets; opened up direct access for foreign investors into China’s interbank bond market; and approved a two-way, cross-border equity direct investment scheme between Shanghai and Hong Kong that allows Chinese investors to trade designated Hong Kong-listed stocks through the Shanghai Exchange, and vice versa. Direct investment by private equity and venture capital firms is also rising, although from a small base, and has faced setbacks due to China’s capital controls that complicate the repatriation of returns.

While the central bank’s official position is that companies with proper documentation should be able to freely conduct business, in practice, companies have reported challenges and delays in getting foreign currency transactions approved by sub-national regulatory branches. In 2017, several foreign companies complained about administrative delays in remitting large sums of money from China, even after completing all of the documentation requirements. Such incidents come amid announcements that the State Administration of Foreign Exchange (SAFE) had issued guidance to tighten scrutiny of foreign currency outflows due to China’s rapidly decreasing foreign currency exchange. China has since announced that it will gradually reduce those controls, but market analysts expect they would be re-imposed if capital outflows accelerate again.

Under Chinese law, FIEs do not need pre-approval to open foreign exchange accounts and are allowed to retain income as foreign exchange or to convert it into RMB without quota requirements. Foreign exchange transactions related to China’s capital account activities do not require review by SAFE, but designated foreign exchange banks review and directly conduct foreign exchange settlements. Chinese officials register all commercial foreign debt and will limit foreign firms’ accumulated medium- and long-term debt from abroad to the difference between total investment and registered capital. China issued guidelines in February 2015 that allow, on a pilot basis, a more flexible approach to foreign debt within several specific geographic areas, including the Shanghai Pilot FTZ. The main change under this new approach is to allow FIEs to expand their foreign debt above the difference between total investment and registered capital, so long as they have sufficient net assets.

Chinese foreign exchange rules cap the maximum amount of RMB individuals are allowed to convert into other currencies at approximately USD 50,000 each year and restrict them from directly transferring RMB abroad without prior approval from SAFE. In 2017, authorities further restricted overseas currency withdrawals by banning sales of life insurance products and capping credit card withdrawals at USD 5,000 per transaction. SAFE has not reduced this quota, but during periods of higher than normal capital outflows, banks are reportedly instructed by SAFE to increase scrutiny over individuals’ requests for foreign currency and to require additional paperwork clarifying the intended use of the funds, with the express intent of slowing capital outflows.

China’s exchange rate regime is managed within a band that allows the currency to rise or fall by 2 percent per day from the “reference rate” set each morning. In August 2015, China announced that the reference rate would more closely reflect the previous day’s closing spot rate. Since that change, daily volatility of the RMB has at times been higher than in recent years, but for the most part, remains below what is typical for other currencies. In 2017, the PBOC took additional measures to reduce volatility, introducing a “countercyclical factor” into its daily RMB exchange rate calculation. Although the PBOC reportedly suspended the countercyclical factor in January 2018, the tool remains available to policymakers if volatility re-emerges.

Remittance Policies

The following operations do not require SAFE approval: purchase and remittance of foreign exchange as a result of capital reduction, liquidation, or early repatriation of an investment in a foreign-owned enterprise, or as a result of the transfer of equity in an FIE to a Chinese domestic entity or individual where lawful income derived in China is reinvested.

The remittance of profits and dividends by FIEs is not subject to time limitations, but FIEs need to submit a series of documents to designated banks for review and approval. The review period is not fixed, and is frequently completed within one or two working days of the submission of complete documents. In the past year, this period has lengthened during periods of higher than normal capital outflows, when the government strengthens capital controls.

Remittance policies have not changed substantially since SAFE simplified some regulations in January 2014, devolving many review and approval procedures to banks. Firms that remit profits at or below USD 50,000 dollars can do so without submitting documents to the banks for review. For remittances above USD 50,000, the firm must submit tax documents, as well as the formal decision by its management to distribute profits.

For remittance of interest and principle on private foreign debt, firms must submit an application form, a foreign debt agreement, and the notice on repayment of the principle and interest. Banks will then check if the repayment volume is within the repayable principle.

The remittance of financial lease payments falls under foreign debt management rules. There are no specific rules on the remittance of royalties and management fees. In September 2017, SAFE lowered the reserve requirement for foreign currency transactions to zero, significantly reducing the cost of foreign currency transactions. The reserve ratio was raised to 20 percent in 2016.

The Financial Action Task Force has identified China as a country of primary concern. Global Financial Integrity (GFI) estimates that over USD 1 trillion of illicit money left China between 2003 and 2012, making China the world leader in illicit capital flows. In 2013, GFI estimated that another USD 260 billion left the country.

Sovereign Wealth Funds

China officially has only one sovereign wealth fund (SWF), the China Investment Corporation (CIC). Established in 2007, CIC manages over USD 900 billion in assets (as of August 2017) and invests on a 10-year time horizon. China’s sovereign wealth is also invested by a subsidiary of SAFE, the government agency that manages China’s foreign currency reserves, and reports directly to the PBOC. The SAFE Administrator also serves concurrently as a PBOC Deputy Governor.

China also operates other funds that function in part like sovereign wealth funds, including: China’s National Social Security Fund, with an estimate USD 295 billion in assets; the China-Africa Development Fund (solely funded by the China Development Bank), with an estimated USD 5 billion; the SAFE Investment Company, with an estimated USD 441 billion; and China’s state-owned Silk Road Fund, established in December 2014 with USD 40 billion to foster investment in countries along the Belt and Road. Chinese SWFs do not report the percentage of their assets that are invested domestically.

Chinese SWFs follow the voluntary code of good practices known as the Santiago Principles and participate in the IMF-hosted International Working Group on SWFs. The Chinese government does not have any formal policies specifying that CIC invest funds consistent with industrial policies or in government-designated projects, although CIC is expected to pursue government objectives. The SWF generally adopts a “passive” role as a portfolio investor.

7. State-Owned EnterprisesShare

China has approximately 150,000 SOEs, of which around 50,000 (33 percent) are owned by the central government and the remainder by local governments. The central government directly controls and manages 97 strategic SOEs through the State Assets Supervision and Administration Commission (SASAC), of which around 60 are listed on stock exchanges domestically and/or internationally. SOEs, both central and local, account for 30 to 40 percent of total GDP and about 20 percent of China’s total employment. The percentage of SOE revenue spent on research and development is unknown. SOEs can be found in all sectors of the economy, from tourism to heavy industries.

China’s leading SOEs benefit from preferential government policies aimed at developing bigger and stronger “national champions.” SOEs enjoy favored access to essential economic inputs (land, hydrocarbons, finance, telecoms, and electricity) and exercise considerable power in markets like steel and minerals. SOEs have long enjoyed preferential access to credit and the ability to issue publicly traded equity and debt. SOEs also are not subject to the same tax burdens as their private sector competitors. According to some Chinese academics, provincial governments have used their power to manipulate industrial policies and deny operating licenses to domestic and foreign investors in order to persuade reluctant owners to sell out to bigger, state-owned suitors.

During the November 2013 Third Plenum of the 18th Party Congress – a hallmark session that announced economic reforms, including calling for the market to play a more decisive role in the allocation of resources – President Xi Jinping called for broad SOE reforms. Cautioning that SOEs still will remain a key part of China’s economic system, Xi emphasized improved SOE operational transparency and legal reforms that would subject SOEs to greater competition by opening up more industry sectors to domestic and foreign competitors and by reducing provincial and central government preferential treatment of SOEs. The Third Plenum also called for “mixed ownership” economic structures, providing greater economic balance between private and state-owned businesses in certain industries, including equal access to factors of production, competition on a level playing field, and equal legal protection.

At the March 2018 NPC, Premier Li Keqiang’s annual government work report highlighted that SOE reforms would continue along the same track: SOEs would become “leaner, better performers” through restructuring and deepening of corporate decision making, while state capital would continue in importance. At a press conference held during the March 2018 NPC, SASAC Chairman Xiao Yaqing noted that SOEs had shed 8,390 employees, and 1,200 unprofitable “zombie enterprises” were eliminated in 2017, realizing 163.4 billion RMB (USD 25.8 billion) in cost savings.

OECD Guidelines on Corporate Governance

SASAC participates in the OECD Working Party on State Ownership and Privatization Practices (WPSOPP). Chinese officials have indicated China intends to utilize OECD SOE guidelines to improve the professionalism and independence of SOEs, including relying on Boards of Directors that are independent from political influence. However, despite China’s Third Plenum commitments in 2013 – to foster “market-oriented” reforms in China’s state sectors – Chinese officials and SASAC have made minimal progress in fundamentally changing the regulation and business conduct of SOEs. China has also committed to implement the G-20/OECD Principles of Corporate Governance, which apply to all publicly-listed companies, including listed SOEs.

Chinese law lacks unified guidelines or a governance code for SOEs, especially among provincial or locally-controlled SOEs. Among larger SOEs that are primarily managed by SASAC, senior management positions are filled by senior CCP members who report directly to the CCP. SASAC Chairman Xiao Yaqing reemphasized this point during a March 9, 2017, press conference at the NPC, where he stated newly implemented rules required the chairman of any SOE under his ministry’s control to also be the secretary of the SOE’s CCP committee, as a way of strengthening the Party’s control.

The lack of management independence and the controlling ownership interest of the State make SOEs de facto arms of the government, subject to government direction and interference. SOEs are rarely the defendant in legal disputes, and when they are, they almost always prevail, presumably due to the close relationship with the CCP. U.S. companies often complain about the lack of transparency and objectivity in commercial disputes with SOEs. In addition, SOEs enjoy preferential access to a disproportionate share of available capital, whether in the form of loans or equity.

In its September 2015 Guiding Opinions on Deepening the Reform of State-Owned Enterprises, the State Council instituted a system for classifying SOEs as “public service” or “commercial enterprises.” Some commercial enterprise SOEs were further sub-classified into “strategic” or “critically important” sectors (i.e., with strong national economic or security importance). SASAC has said the new classification system would allow the government to reduce support for commercial enterprises competing with private firms and instead channel resources toward public service SOEs.

Other recent reforms have included salary caps, limits on employee benefits, and attempts to create stock incentive programs for managers that have produced mixed results. However, analysts believe minor reforms will be ineffective as long as SOE administration and government policy are intertwined.

A major stumbling block to SOE reform is that SOE regulators are outranked in the CCP party structure by SOE executives, which minimizes SASAC and other government regulators’ effectiveness at implementing reforms. In addition, SOE executives are often promoted to high-ranking positions in the CCP or local government, further complicating the work of regulators.

During the Third Plenum of the CCP’s 18th Central Committee, in 2013, the CCP leadership announced that the market would play a “decisive role” in economic decision making and emphasized that SOEs needed to focus resources in areas that “serve state strategic objectives.” However, experts point out that despite these new SOE distinctions, SOEs continue to hold dominant shares in their respective industries, regardless of whether they are strategic, which may further restrain private investment in the economy. Moreover, the application of China’s Anti-Monopoly Law, together with other industrial policies and practices that are selectively enforced by the authorities, protects SOEs from private sector competition.

China is not a party to the Government Procurement Agreement (GPA) within the framework of the WTO, although Hong Kong is listed. In April 2018, President Xi announced his intent to join GPA, but no timeline was given for accession.

Investment Restrictions in “Vital Industries and Key Fields”

The intended purpose of China’s State Assets Law is to safeguard and protect China’s economic system, promoting “socialist market economy” principles that fortify and develop a strong, state-owned economy. A key component of the State Asset Law is enabling SOEs to play the leading role in China’s economic development, especially in “vital industries and key fields.” To accomplish this, the law encourages Chinese regulators to adopt policies that consolidate SOE concentrations to ensure dominance in industries deemed vital to “national security” and “national economic security.” This principle is further reinforced by the December 2006 State Council announcement of the Guiding Opinions Concerning the Advancement of Adjustments of State Capital and the Restructuring of State-Owned Enterprises, which called for more SOE consolidation to advance the development of the state-owned economy, including enhancing and expanding the role of the State in controlling and influencing “vital industries and key fields relating to national security and national economic lifelines.” These guidelines defined “vital industries and key fields” as “industries concerning national security, major infrastructure and important mineral resources, industries that provide essential public goods and services, and key enterprises in pillar industries and high-tech industries.”

Around the time the guidelines were published, the SASAC Chairman also listed industries where the State should maintain “absolute control” (e.g., aviation, coal, defense, electric power and the state grid, oil and petrochemicals, shipping, and telecommunications) and “relative control” (e.g., automotive, chemical, construction, exploration and design, electronic information, equipment manufacturing, iron and steel, nonferrous metal, and science and technology). China has said these lists do not reflect its official policy on SOEs. In fact, in some cases, regulators have allowed for more than 50 percent private ownership in some of the listed industries on a case-by-case basis, especially in industries where Chinese firms lack expertise and capabilities in a given technology Chinese officials deemed important at the time.

A key SOE-dominant industry that is insulated from competition is agricultural products. Current agriculture trade rules, regulations, and limitations placed on foreign investment severely restrict the contributions of U.S. agricultural companies, depriving China’s consumers of the many potential benefits additional foreign investment could provide. These investment restrictions in the agricultural sectors are at odds with the objective under China’s 12th Five Year Plan (2012-2017) of shifting more resources to agriculture and food production in order to improve Chinese lives, food security, and food safety.

Privatization Program

At the November 2013 Third Plenum, the Chinese government announced reforms to SOEs that included selling shares of SOEs to outside investors. This approach is an effort to improve SOE management structures, emphasize the use of financial benchmarks, and gradually take steps that will bring private capital into some sectors traditionally monopolized by SOEs like energy, telecommunications, and finance. In practice, these reforms have been gradual, as the Chinese government has struggled to implement its SOE reform vision and often opted to utilize a preferred SOE consolidation approach. In the past few years, the Chinese government has listed several large SOEs and their assets on the Hong Kong stock exchange, subjecting SOEs to greater transparency requirements and heightened regulatory scrutiny. This approach is a possible mechanism to improve SOE corporate governance and transparency. Starting in 2017, the government began pushing the mixed ownership model, in which private companies invest in SOEs and outside managers are hired, as a possible solution, although analysts note that ultimately the government (and therefore the CCP) remains in full control regardless of the private share percentage. Over the last year, President Xi and other senior leaders have increasingly focused reform efforts on strengthening the role of the State as an investor or owner of capital, instead of the old SOE model.

8. Responsible Business ConductShare

General awareness of RBC standards (including environmental, social, and governance issues) is a relatively new concept to most Chinese companies, especially companies that exclusively operate in China’s domestic market. Chinese laws that regulate business conduct use voluntary compliance, are limited in scope, and are frequently cast aside when RBC priorities are superseded by other economic imperatives. The lack of independent NGOs, investment funds, worker unions and organizations, and other business associations that promote RBC contribute to the lack of awareness.

The Foreign NGO Law remains a concern for U.S. organizations due to the restrictions on certain NGO activities, including promotion of RBC and corporate social responsibility (CSR) best practices. For U.S. investors looking to partner with a Chinese company or to expand operations by bringing in Chinese suppliers, finding partners that meet internationally recognized standards in areas like labor, environmental protection, work safety, and manufacturing best practices is a challenge. However, the Chinese government has placed greater emphasis on protecting the environment and elevating sustainability as a key priority, resulting in more Chinese companies adding environmental concerns to their CSR initiatives.

In 2014, China signed a memorandum of understanding (MOU) with the OECD to cooperate on RBC initiatives. This MOU, however, does not require or necessarily mean that Chinese companies will adhere to the OECD Guidelines for Multinational Enterprises. Industry leaders have pushed for China to comply with OECD guidelines and establish a national contact point or RBC center. As a result, MOFCOM in 2016 launched the RBC Platform, which serves as the national contact point on RBC issues and supplies information to companies about RBC best practices in China.

In 2014, China participated in the OECD’s RBC Global Forum, including hosting a workshop in Beijing in May 2015. Policy developments from the workshops included incorporation of human rights into social responsibility guidelines for the electronics industry; referencing the United Nations Guiding Principles on Business and Human Rights; mandating social impact assessments for large footprint projects; and agreeing to draft a new law on public participation in environmental protection and impact assessments.

The MOFCOM-affiliated Chinese Chamber of Commerce of Metals, Minerals, and Chemical Importers and Exporters (CCCMC) also signed a separate MOU with the OECD in October 2014, to help Chinese companies implement RBC policies in global mineral supply chains. In December 2015, CCCMC released Due Diligence Guidelines for Responsible Mineral Supply Chains, which draw heavily from the OECD Due Diligence Guidelines. China is currently drafting legislation to regulate the sourcing of minerals, including tin, tungsten, tantalum, and gold, from conflict areas. China is not a member of the Extractive Industries Transparency Initiative (EITI), but Chinese investors participate in EITI schemes where these are mandated by the host country.

9. CorruptionShare

Corruption remains endemic in China. The lack of an independent press, along with the lack of independence of corruption investigators, who answer to and are managed by the CCP, all hamper the transparent and consistent application of anti-corruption efforts.

Chinese anti-corruption laws have strict penalties for bribes, including accepting a bribe, which is a criminal offense punishable up to life imprisonment or death in “especially serious” circumstances. Offering a bribe carries a maximum punishment of up to five years in prison, except in cases with “especially serious” circumstances, when punishment can extend up to life in prison.

In August 2015, the NPC amended several corruption-related parts of China’s Criminal Law. For instance, bribing civil servants’ relatives or other close relationships is a crime with monetary fines imposed on both the bribe-givers and the bribe-takers; bribe-givers, mainly in minor cases, who aid authorities can be given more lenient punishments; and instead of basing punishments solely on the specific amount of money involved in a bribe, authorities now have more discretion to impose punishments based on other factors.

In February 2011, an amendment was made to the Criminal Law, criminalizing the bribing of foreign officials or officials of international organizations. However, to date, there have not been any known cases in which someone was successfully prosecuted for offering this type of bribe.

In March 2018, the NPC approved the creation of the National Supervision Commission (NSC), a new government anti-corruption agency that absorbed the current functions carried out by the Ministry of Supervision, anti-corruption units of the Supreme People’s Procuratorate, and those of the National Bureau of Corruption Prevention. In addition to China’ 89 million CCP members, the new commission has jurisdiction over all civil servants and employees of state enterprises, as well as managers in public schools, hospitals, research institutes, and other public service institutions. Lower-level supervisory commissions have been set up in all provinces, autonomous regions, municipalities, and the Xinjiang Production and Construction Corps. The NPC also passed the State Supervision Law, which provides the NSC with its legal authorities to investigate, detain, and punish public servants.

The CCP’s Central Commission for Discipline Inspection (CCDI) will remain the primary body for enforcing ethics guidelines and party discipline, operating in parallel to the new NSC.

President Xi Jinping’s Anti-Corruption Efforts

Since President Xi’s rise to power in 2012, China has undergone an intensive and large-scale anti-corruption campaign, with investigations reaching into all sectors of the government, military, and economy. President Xi labeled endemic corruption as an “existential threat” to the very survival of the CCP that must be addressed. Since then, each CCP annual plenum has touched on judicial, administrative, and CCP discipline reforms needed to thoroughly root out corruption. Judicial reforms are viewed as necessary to institutionalize the fight against corruption and reduce the arbitrary power of CCP investigators, but concrete measures have emerged slowly. To enhance regional anti-corruption cooperation, the 26th Asia-Pacific Economic Cooperation (APEC) Ministers Meeting adopted the Beijing Declaration on Fighting Corruption in November 2014.

According to official statistics, from 2012 to 2017 the CCDI investigated 1.55 million cases – more than the total of the preceding ten years. In 2017 alone, the CCP disciplined around 527,000 individuals. However, the majority of officials only ended up receiving internal CCP discipline and were not passed forward for formal prosecution and trial. A total of 195,000 corruption and bribery cases involving 263,000 people were heard in courts between 2013 and 2017, according to the Supreme People’s Court. Of these, 101 were officials at or above the rank of minister or head of province. One group heavily disciplined in recent years has been the discipline inspectors themselves, with the CCP punishing more than 7,900 inspectors since late-2012. This led to new regulations being implemented in 2016 by CCDI that increased overall supervision of its investigators.

China’s overseas fugitive-hunting campaign, called “Operation Skynet,” has led to the capture of around 3,800 fugitives suspected of corruption. In 2017 alone, CCDI reported that 1,300 fugitives suspected of official crimes were apprehended, including 347 corrupt officials and 14 priority suspects. The Chinese government reported it recovered 980 million RMB (U.S. USD 151.69 million) in losses from graft over the course of 2017.

Anecdotal information suggests the Chinese government’s anti-corruption crackdown oftentimes is inconsistently and discretionarily applied, raising concerns among foreign companies in China. For example, to fight rampant commercial corruption in the medical/pharmaceutical sector, China’s health authority issued “black lists” of firms and agents involved in commercial bribery. Several blacklisted firms were foreign companies. Additionally, anecdotal information suggests many Chinese government officials responsible for approving foreign investment projects, as well as some routine business transactions, are slowing approvals to not arouse corruption suspicions, making it increasingly difficult to conduct normal commercial activity.

While central government leadership has welcomed increased public participation in reporting suspected corruption at lower levels, direct criticism of central government leadership or policies remains off-limits and is seen as an existential threat to China’s political and social stability. Some citizens who have called for officials to provide transparency and public accountability by disclosing public and personal assets, or who have campaigned against officials’ misuse of public resources, have been subject to criminal prosecution.

China ratified the United Nations Convention against Corruption in 2005 and participates in APEC and OECD anti-corruption initiatives. China has not signed the OECDConvention on Combating Bribery, although Chinese officials have expressed interest in participating in the OECD Working Group on Bribery meetings as an observer.

Resources to Report Corruption

The following government organization receives public reports of corruption:

10. Political and Security EnvironmentShare

The risk of political violence directed at foreign companies operating in China remains low. Each year, government watchdog organizations report tens of thousands of protests throughout China. The government is adept at handling protests without violence, but given the volume of protests annually, the potential for violent flare-ups is real. Violent protests, while rare, have generally involved ethnic tensions, local residents protesting corrupt officials, environmental and food safety concerns, confiscated property, and disputes over unpaid wages.

In recent years, the growing number of protests over corporate M&As has increased, often because disenfranchised workers and mid-level managers feel they were not included in the decision process. There have also been some cases of foreign businesspeople that were refused permission to leave China over pending commercial contract disputes. Chinese authorities have broad authority to prohibit travelers from leaving China (known as an “exit ban”) and have imposed exit bans to compel U.S. citizens to resolve business disputes, force settlement of court orders, or facilitate government investigations. Individuals not directly involved in legal proceedings or suspected of wrongdoing have also been subject to lengthy exit bans in order to compel family members or colleagues to cooperate with Chinese courts or investigations. Exit bans are often issued without notification to the foreign citizen or without a clear legal recourse to appeal the exit ban decision.

In the past few years, Chinese authorities have detained or arrested several foreign nationals, including American citizens, and have refused to notify the U.S. Embassy or allow access to the American citizens detained for consular officers to visit. These trends are in direct contravention of recognized international agreements and conventions.

China’s non-transparent legal and regulatory system allows the CCP to pressure or punish foreign companies for the actions of their governments. The government has also encouraged protests or boycotts of products from certain countries, like Korea, Japan, Norway, and the Philippines, in retaliation for unrelated policy decisions. Examples of politically motivated economic retaliation against foreign firms include boycott campaigns against Korean retailer Lotte in 2016 and 2017 in retaliation for the decision to deploy the Thermal High Altitude Area Defense (THAAD) to the Korean Peninsula, which led to Lotte closing and selling its China operations; and high-profile cases of gross mistreatment of Japanese firms and brands in 2011 and 2012 following disputes over islands in the East China Sea.

11. Labor Policies and PracticesShare

For U.S. companies operating in China, finding adequate human resources remains a major challenge. Finding, developing, and retaining domestic talent, particularly at the management and highly-skilled technical staff levels, remain difficult challenges often cited by foreign firms. In addition, labor costs continue to be a concern, as salaries along with other inputs of production have continued to rise. Foreign companies also continue to cite air pollution concerns as a major hurdle in attracting and retaining qualified foreign talent to relocate to China. These labor concerns contribute to a small, but growing, number of foreign companies relocating from China to the United States, Canada, Mexico, or other parts of Asia.

Chinese labor law does not protect rights such as freedom of association and the right of workers to strike. China to date has not ratified the United Nations International Labor Organization conventions on freedom of association and collective bargaining, but it has ratified conventions prohibiting child labor and employment discrimination. Foreign companies often complain of difficulty navigating China’s ever-evolving labor laws, social insurance laws, and different agencies’ implementation guidelines on labor issues. Compounding the complexity, local characteristics and the application by different localities of national labor laws often vary.

Although required by national law, labor contracts are often not used by domestic employers with local employees. Without written contracts, employees struggle to prove employment, thus losing basic labor rights like claiming severance and unemployment compensation if terminated, as well as access to publicly-provided labor dispute settlement mechanisms. Similarly, regulations on agencies that provide temporary labor (referred to as “labor dispatch” in China) have tightened, and some domestic employers have switched to hiring independent service provider contractors in order to skirt the protective intent of these regulations. These loopholes incentivize employers to skirt the law because compliance leads to substantially higher labor costs. This is one of many factors contributing to an uneven playing field for foreign firms that compete against domestic firms that circumvent local labor laws.

Establishing independent trade unions is illegal in China. The law allows for worker “collective bargaining”; however, in practice, collective bargaining focuses solely on collective wage negotiations – and even this practice is uncommon. The Trade Union Law gives the All-China Federation of Trade Unions (ACFTU), a CCP organ chaired by a member of the Politburo, control over all union organizations and activities, including enterprise-level unions. The ACFTU’s priority task is to “uphold the leadership of the Communist Party,” not to protect workers’ rights or improve their welfare. The ACFTU and its provincial and local branches aggressively organize new constituent unions and add new members, especially in large multinational enterprises, but in general, these enterprise-level unions do not actively participate in employee-employer relations. The absence of independent unions that advocate on behalf of workers has resulted in an increased number of strikes and walkouts in recent years.

ACFTU enterprise unions issue a mandatory employer-borne cost of 2 percent of payroll for membership. While labor laws do not protect the right to strike, “spontaneous” worker protests and work stoppages occur with increasing regularity, especially in labor intensive and “sunset” industries (i.e., old and declining industries such as low-end manufacturing). Official forums for mediation, arbitration, and other similar mechanisms of alternative dispute resolution have generally been ineffective in resolving labor disputes in China. Some localities actively discourage acceptance of labor disputes for arbitration or legal resolution. Even when an arbitration award or legal judgment is obtained, getting local authorities to enforce judgments is problematic.

12. OPIC and Other Investment Insurance ProgramsShare

In the aftermath of the Chinese crackdown on Tiananmen Square demonstrations in June 2019, the United States suspended Overseas Private Investment Corporation (OPIC) programs in China. OPIC honors outstanding political risk insurance contracts. The Multilateral Investment Guarantee Agency, an organization affiliated with the World Bank, provides political risk insurance for investors in China. Some foreign commercial insurance companies also offer political risk insurance, as does the People’s Insurance Company of China.

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